China's Aging Population Becoming More Of A Problem

Many investors think of China as rich. But outside of a handful of east coast exporting cities and Beijing, it is still poor and getting old. How will the government take care of all these people? (Photo by Kevin Frayer/Getty Images)

China's getting old. In fact, they are getting older faster than anywhere else in the world. And the Chinese government has a very weak safety net to cover for them all.

According to the United Nations, China is ageing more rapidly than almost any country in recent history. China’s dependency ratio for retirees could rise as high as 44% by 2050. The dependency ratio compares the difference between those not in the labor force with those who are working, or can work full-time. It is a yardstick geared to measure the pressure on taxable income going to support entitlement programs like Social Security and Medicaid in the U.S. for example. China's aging population is as big a worry as its debt bomb, if not more so, because China can make its debt disappear at the stroke of a pen, but the government cannot make millions of elderly and retirees disappear.

For Wall Street, China's unfavorable demographics are worth watching. It would be different if this was some rich Nordic country, or Japan, an Asian neighbor with its own demographic woes. China is getting old at a time when its middle income earners and the entrepreneurial class is still in the early innings of spreading its wings. These financial strains on the government will force policymakers to re-evaluate spending, and that could easily threaten economic stimulus programs investors have come to expect from Beijing in times of economic slowdowns.

"China’s rising public debt and slowing growth will make reaching it stated goal of extending pension coverage to everyone, especially the hundreds of millions of migrant (Chinese) laborers with inadequate personal savings and no retirement coverage, very difficult," warns Alex Wolf, emerging markets economist with Standard Life Investments, a $360 billion asset manager headquartered in Edinburgh.

The International Monetary Fund says China’s public debt load amounts to slightly over 60% of GDP, though other China-watchers say it is double that. China's public sector balance sheet is one of the more indebted in the emerging markets and likely more than that of Brazil, always one of the highest debt-to-GDP ratios in the big four emerging markets.

Within the BRICs, Russia too faces demographic challenges. Immigration is low, and more Russians are moving out than foreigners are moving in. Russia's average population is actually older than China's at 39. China's median age is 37. The problem is quantity. China has about a billion more people than Russia.

A baby boom under Mao Zedong was followed by 36 years of a one-child policy that created distortions in the economy. Many poor, isolated people in the countryside had more than one child. The wealthy had one, and a generation of wealth was passed down to one child instead of dividing it up among the siblings. Wealth was easily concentrated. This created enormous distortions of net wealth in China. Disparity between rich and poor in China is as bad as it ever was. The richest 1% of households one a whopping 30% of China's wealth, according to a Peking University study.

"We are underweight China, and significantly so," says Gerardo Zamorano, an investment director for Brandes in San Diego.

Ancient Chinese Secret

The problem from an investor's point of view is that China has relied on government credit to help its economy grow. As the population ages, the government will need to revert some of that funding to take care of the elderly on fixed income, and pay out public pensions for those workers in the formal economy. One could argue that the government of China is not really known for putting money to work where investment returns are guaranteed. Credit expansion might measure demand in an economy like Russia's, and surely here in the U.S. But in China, credit expansion also means money to build "ghost cities" or loans to provincial governments who then hand it off to private companies, often owned by friends of politicians. For sure a larger part of those lending decisions are coming with guaranteed jobs for working class, low income Chinese. In other words, China may have to divert money to retirees but at least investors will know where it is going.

The UN estimates that China's retirees will go from approximately 100 million in 2005 to around 330 million in 2050, roughly the population of the United States, but without the social safety net and money to take care of them all. (Photo by JOHANNES...

On the other hand, as Standard Life's Alex Wolf points out, diverting government funds to retirees and the elderly means China has "less space for fiscal stimulus, while at the same time it will confront the traditional ‘guns versus butter’ debate," he says.

China is getting old. According to the UN, it will take China just 20 years for the proportion of the elderly population to double from 10% to 20% (between 2017-2037). The next closest is Japan where it took 23 years. By comparison, it took 61 years in Germany and 64 years in Sweden. China’s dependency ratio for retirees -- those aged 65 or older divided by total working population -- as at 2015 was 14%. The UN estimates this could rise as high as 44% by 2050 with the number of those over 65 rising from approximately 100 million in 2005 to approximately 330 million in 2050, roughly the population of the United States and twice the current population of Russia.

Demographics should be an important piece of the equation for China-bound investors and analysts. Says Wolf, "China lacks many of the welfare capabilities that wealthier countries had during their demographic transitions."

Rob Lutts, chief investment officer and founder of Cabot Wealth Management, a $600 million family office in Salem, Mass., was in China in January. "I think the feeling is that China will manage through its challenging periods" he says. "They understand how stimulus works and where the money goes. I would say they are cautiously optimistic."